Question

Assume the marginal propensity to save is 0.10. Firms become optimistic and increase investment spending by $10 billion. Other things being equal, real GDP will:

Answer 1

The real GDP will increase by $20 billion if the MPS equals 0.10 and investment spending increases by $10 billion.

What is MPS?

MPS stands for marginal propensity to save which is determined by deducting the MPC value from 1. This value is used in computing the investment multiplier.

Given values:

MPS = 0.10

Change in investment spending (increase) = $10 billion

Computation of change in real GDP (increase):

$\rm\ Change \rm\ in \rm\ real \rm\ GDP=\rm\ Multiplier\times\ \rm\ Change \rm\ in \rm\ investment \rm\ spending\\\rm\ Change \rm\ in \rm\ real \rm\ GDP=\frac{1}{MPS}\times\ \ 10\rm\ billion\\\rm\ Change \rm\ in \rm\ real \rm\ GDP=10\times\ \ 10\rm\ billion\\\rm\ Change \rm\ in \rm\ real \rm\ GDP= 20\rm\ billion$

Therefore, when the investment spending increased by $10 billion with MPS equal to 0.10 then the real GDP will also increase by $20 billion.

Learn more about change in real GDP in the related link:

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